QUESTION 1 100 marks

Razzmatazz (Pty) Ltd operates 12 theatres in major cities in South Africa. The company was established by a group of entrepreneurs with significant experience in the music industry. The first Razzmatazz theatre was opened in Pretoria in 2000 and immediately became popular amongst music lovers. The success of the first venue led to Razzmatazz (Pty) Ltd opening a further 11 theatres over the next three years.

Razzmatazz (Pty) Ltd theatres offer patrons the opportunity to enjoy high quality musical shows. The company has flourished at a time when theatre attendance generally has been on the decline. Razzmatazzs musical theme shows have entranced audiences due to the quality of productions and the brilliance of cast members. Patrons are permitted to purchase alcoholic and other beverages on the premises to consume before and during shows. However, Razzmatazz does not serve food or meals.

The company commissions independent contractors to write and produce musical shows on an annual basis. All rights to such shows are owned by Razzmatazz (Pty) Ltd and these shows may only be staged at its theatres. Independent contractors are paid a fixed amount per new show for their creative work. The company has its own casting directors, musical directors and choreographers who select cast members and direct and rehearse their performances. The company offers musicians and artists contract employment for the duration of shows, and hence does not offer them permanent employment.

Razzmatazz (Pty) Ltd has approximately six different shows running at its 12 theatres nationally, at any point in time. These shows are rotated amongst the different theatres and care is taken to ensure that the same shows are not featured at theatres in close proximity to each other. The company commissions four new musical shows per year to continually provide patrons with opportunities to see new musicals.

Each theatre can accommodate 350 patrons and has standardised dcor. The company has historically leased premises and lease agreements are generally for ten-year periods with five-year renewal options. Razzmatazz (Pty) Ltd is planning to build and own its theatres in future. This change in strategy resulted from the high cost of leasing premises and will enable the company to effectively utilise its free cash flow annually. Historically, surplus cash has been distributed annually to shareholders in the form of dividends.

Razzmatazz (Pty) Ltd plans to build and open two new theatres (350 seats in each) during the 2005 financial year. The cost of erecting such theatres is estimated at R15 million each. Sound equipment and furniture and fittings for each theatre are expected to cost a further R2,5 million per venue. The new theatres are to be financed by means of long-term loans from a commercial bank repayable over a ten-year period. Commercial banks have adopted the view that theatre buildings provide limited security for loans due to their specialised nature and use. Accordingly, loans are to be secured by a pledge of movable and immovable assets of Razzmatazz (Pty) Ltd, as well as personal suretyships from individual shareholders. Loans will bear interest at 1,5% above the prevailing prime overdraft lending rate, which is currently 11% per annum.

There are four individual shareholders who collectively own 100% of the shares in issue of Razzmatazz (Pty) Ltd. These individuals are all executive directors and are actively involved in the business.

The shareholders and executive directors of Razzmatazz (Pty) Ltd are concerned about the following issues facing the business:

The terms of the loan finance from the commercial bank. They are unwilling to provide personal

suretyships, on a joint and several basis, to secure loans. In addition, they consider the interest rate to be very high in comparison to normal property finance rates. They are also unsure whether to opt for a fixed or floating interest rate.

The financial results of Razzmatazz (Pty) Ltd for the year ended 31 October 2004 were lower than the budgeted results approved by the board in November 2003.

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The business has grown phenomenally since inception. The shareholders are of the opinion that measures need to be introduced to monitor the performance of the company. Currently, Razzmatazz (Pty) Ltd has no performance measures in place, apart from annual budgets, with which to benchmark operating performance. The shareholders have heard that the Balanced Scorecard is an effective framework to link financial and non-financial performance measures and that it also facilitates comprehensive evaluation and feedback. A management consultancy firm has provided the Razzmatazz (Pty) Ltd shareholders with a brief overview of the Balanced Scorecard and how it attempts to provide the following different perspectives of a business:

Customer perspective

Internal business process perspective

Learning and growth perspective

Financial perspective.

Sound equipment for the new theatres will be imported from the USA on normal trade terms. The budgeted cost of sound equipment for the two new theatres to be opened during the 2005 financial year amounts to R3 million. Historically, Razzmatazz (Pty) Ltd has not taken out forward cover on imports and no formal hedging policy is in place. Given the rands strength against the US dollar over the past 12 months, the shareholders are concerned about a potential rand devaluation.

Attendance levels at Razzmatazz theatres have been declining over the past year. The shareholders are considering different strategies to boost attendance, including lowering ticket prices.

The budget and actual financial results of Razzmatazz (Pty) Ltd for the year ended 31 October 2004 as well as the draft budget for the 2005 financial year are summarised below:

RAZZMATAZZ (PTY) LTD

INCOME STATEMENT FOR THE YEAR ENDED 31 OCTOBER 2004 _________________________________________________________________________________

Revenue

Ticket sales Beverage sales

Cost of sales

Ticketing agent commission Contractors fees for new shows Beverage costs

New show stage props Musicians and artist fees Gross profit

Overheads

Depreciation

Marketing costs

Salaries and wages

Rental of premises

Travelling and accommodation Utility costs

Other overheads

Profit from operations

Net interest income/finance costs

Profit before tax

Budget 2004

Notes R000

87 465 1 72 030 15 435

(36 582) 1 (4 682) (1 000) (7 718) 2 (500) (22 682)

50 883

(44 007) 3 (2 205) (2 650) (9 500) 4 (21 600) 5 (4 100) (1 152)

6 (2 800) 6 876

320 7 196

Actual 2004

R000

88 715 70 913 17 802

(38 664) (5 106) (1 100) (7 120)

(820) (24 518)

50 051

(46 038) (2 105) (2 960)

(10 140) (21 750) (4 260) (1 486)

(3 337) 4 013

42 4 055

Budget 2005

R000

102 048 81 982 20 066

(40 859) (5 329) (1 180) (8 026)

(750) (25 574)

61 189

(53 455) (4 498) (3 200)

(11 530) (23 707) (4 775) (1 770)

(3 975) 7 734

(1 650) 6 084

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Notes

1 Although Razzmatazz does sell tickets directly, the majority of sales are through an independent ticketing agent who has a national call centre infrastructure. Commission of 10% of the face value of tickets is paid to the independent ticketing agent. The company operated 12 theatres throughout the 2004 financial year, each with a capacity of 350 seats. The two new theatres are scheduled to open on 1 February 2005 and 1 August 2005. The budgeted and actual attendance statistics and ticket sales for the year ended 31 October 2004, and budget assumptions for the year ending 31 October 2005 are summarised below:

October year end

Tickets sold

Trading weeks at each theatre

Theatres open and trading for the year Number of shows per week at each theatre Maximum number of tickets available for sale Average ticket price

Budget 2004 1 029 000 50 12 7 1 470 000 R70,00

Actual 2004 984 900 50 12 7 1 470 000 R72,00

Budget 2005 1 146 600 50 13 7 1 592 500 R71,50

2 Construction costs of stage props for new shows are expensed in the year they are incurred.

3 Leasehold improvements, sound equipment and furniture and fittings are depreciated over a ten-year period. Depreciation is budgeted to increase significantly in 2005 because of the new

theatres being opened. Buildings are to be depreciated over 20 years.

4 Budgeted rental escalations are 9% based on the terms of lease agreements.

5 Musicians and artists sometimes follow particular shows from theatre to theatre. The majority of

travelling and accommodation costs per the income statements relate to expenses incurred by

cast members travelling to different cities and their accommodation costs.

6 Other overheads are fixed in nature.

The balance sheet of Razzmatazz (Pty) Ltd at 31 October 2004 is summarised below:

RAZZMATAZZ (PTY) LTD BALANCE SHEET AT 31 OCTOBER 2004

ASSETS

Non-current assets Property, plant and equipment

Current assets

Trade and other receivables Cash and cash equivalents

Total assets

EQUITY AND LIABILITIES Capital and reserves Share capital and premium Retained income

Current liabilities

Trade and other payables Tax

Total equity and liabilities

R000

12 850

1 275 1 140 135

14 125

1 500

6 338

7 838

6 287 5 314 973

14 125

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REQUIRED

(a) Critically analyse the actual results of Razzmatazz (Pty) Ltd for the year ended 31 October 2004 and compare the results against the budget. Your answer should include

(i) computations of key ratios and variances; (12)

(ii) commentary on the major variances between actual and budgeted performance; and (10)

(iii) highlight any major issues that the executive directors of Razzmatazz (Pty) Ltd should

address as evident from your analysis. (3)

(b) Calculate the number of tickets that need to be sold in the 2005 financial year in order to break even. Assume that the utility, marketing and travelling and accommodation costs are fixed in nature. In addition, you should assume that 65% of all ticket sales occur through the

independent ticketing agent. (10)

(c) Review and evaluate the draft budget income statement for the year ending 31 October 2005 and identify any issues and assumptions that may require revision before the board of directors

of Razzmatazz (Pty) Ltd approve the budget. Show all your workings. (13)

(d) Critically evaluate the decision of Razzmatazz (Pty) Ltd to build and own its theatres as opposed to leasing premises in future, and consider the potential financial impacts of this decision and the risks inherent in pursuing this strategy. Indicate whether you agree with their

decision and provide detailed reasons for your conclusion. (10)

(e) Critically comment on the concerns that the shareholders of Razzmatazz (Pty) Ltd have expressed regarding the proposed loan terms from the commercial bank. (6)

(f) Discuss the factors to be considered in evaluating whether to opt for a fixed interest rate as

opposed to a floating interest rate on the loan from the commercial bank. (5)

(g) Recommend general and specific hedging techniques that can be used to minimise foreign currency exchange rate risks arising from the import of sound equipment. (5)

(h) Outline the core principles underlying the Balanced Scorecard and the possible benefits to

Razzmatazz (Pty) Ltd of adopting this performance measurement system. (8)

(i) List, with reasons, five key performance measures that could be used to monitor and evaluate the companys financial performance. (10)

(j) Identify and discuss ways in which the company could improve profitability. (8)